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Deciphering the New Rules for Repair Costs

(April 2014) posted on Tue Apr 01, 2014

The IRS has issued final regulations addressing whether a cost is a deductible repair or a capital expenditure.

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By Mark E. Battersby

Since the very inception of the Internal Revenue Code, the IRS and businesses – including print service providers – have been at odds over whether expenditures made are currently deductible, or whether they must be capitalized and recovered through depreciation over time. Now, after seven years of drafts and proposed rules, the IRS has issued final regulations addressing whether a cost is a deductible repair or a capital expenditure.

In addition, the IRS has released a long-awaited Revenue Procedure detailing the procedures for obtaining the “automatic” consent of the IRS to change accounting methods, as required by these new repair regulations.

Repair or improvement?
Since the Reconstruction Era Income Tax Act of 1870, taxpayers have been prohibited from deducting amounts paid for new buildings, permanent improvements, or “betterments” to business property made to increase the value of business property. While this concept has been recognized as part of US tax law almost from its inception, exactly what must be capitalized and what can be currently deducted as an expense has been at issue ever since.

The IRS’s newly released regulations, however, serve to provide guidance on a number of questions – such as whether replacing a component of a building is a current deduction or whether it must be depreciated over 39 years.

Expenditures that restore property to its operating state are, according to the IRS, a deductible repair. However, expenditures that provide a more permanent increment in longevity, utility, or worth of the property are more likely capital in nature.

If, for example, a print shop rebuilds the motor on an in-house machine, the IRS usually considers that expenditure to be a capital expense. In the IRS view, rebuilding a motor increases the value of the machine (the unit of property) and prolongs its economic useful life. By comparison, the IRS deems regularly scheduled maintenance repairs as currently deductible – since they don’t materially increase the asset’s value or appreciably prolong its useful life.

In general, the new regulations distinguish between amounts paid to acquire or produce business property, equipment, or machinery, and those amounts that are paid to improve existing property. When it comes to “improvements” to business property, capitalization is required if the expenditure is a betterment, restoration, or adaptation of the unit of property.